London Session: Drifting into payrolls…

The markets are fairly stable as we wait for the latest payrolls report from the US. Stocks have been fairly flat, and are down just a touch midway through the European session. Within the next 30 minutes we will find out how many jobs the US created last month. In the midst of the European sovereign debt crisis it is easy to forget that the flagging US economic recovery is the other major issue that is weighing on risk appetite right now.

The market consensus is for a 55k increase in jobs; however, there are some technical factors that could skew this month's figures. Last month 45,000 Verizon workers were on strike that may have impacted the payrolls rate, however they went back to work in September so this could have an upward impact on payrolls. But more encouragingly for this month's payrolls print was the increase in the employment sub-index of the September ISM manufacturing survey. This jumped from 51.8 in August to 53.8 last month and tends to track developments in the economy very closely.

Even though solving the European debt crisis and recapitalising the region's banks is the most pressing issue on the markets' minds right now, the US economy cannot be ignored and its health will be crucial for stocks and the future of corporate profits to sustain this rally. In the run up to payrolls the markets in Europe have been extremely quiet. The dollar has had a mixed session, but the euro has managed to hold onto its gains.

The major mover in G10 has been the pound. QE - what QE? Sterling has shrugged off a torrent of bad news: 1, news that the BOE would pump the economy with another GBP75bn, which is traditionally negative for the domestic currency; 2, The Moody's downgrade of 12 UK financial institutions and 3, a story in the FT that RBS would need another bailout and is not strong enough to stand on its own two feet. So it would seem the pound is defying gravity as we move into the end of the week. GBPUSD is testing resistance at 1.5550. Above here opens the way to 1.5620 - 21-day sma then towards 1.6000. The performance of the pound is crucial for the BOE in the coming weeks and months. A weak pound is good for exports, however the Bank may not want to see the pound weaken too much as it would only make imports even more expensive and put further upward pressure on sterling. So it will be a difficult balancing act for the Bank as we move through to the end of the year. On balance we think that QE is negative for the pound and would be a seller on rallies.

It seems like there has been a shift in investors' attitude in recent days and there are early signs of a return of confidence to the markets. However, today's more cautious mood reminds us that Europe's problems are far from solved. The ECB has continued to buy Italian and Spanish debt this week and Italian bond yields have spiked back to the 5.6% area. New ECB President (who takes the helm on 1 November) Mario Draghi was speaking today and said that structural reform is an absolute priority for Italy, yet the Berlusconi government continues to drag its feet on the bold reforms that the market craves.

The German and French leaders are meeting on Sunday to discuss bank re-capitalisations plans. Europe is still at a critical phase, and although bank re-capitalisations are necessary you don't want to put the cart before the horse. Europe needs to deal with its solvency problems and they cannot be pushed to the back burner. Reforms are vital, there needs to be evidence of budget consolidation and a return to competitiveness before we can say with any degree of certainty that Europe has survived the crisis. The fact that German Chancellor Angela Merkel said that Greece will not be on the agenda of the 17-18 October ERU summit worries me slightly, even though the topic of bank re-capitalisation is important to address the EU leaders can't take their eye off the ball and need to come up with a way for the EFSF to be the backstop for solvent sovereigns in the currency bloc so that Spain, Italy and France don't get dragged into the fray further down the line.

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